A spring cleaning for the stocks in your portfolio
The market is telling us how to sort out our portfolios, say these Canadian small cap stock specialists as they deal with five stocks.
It’s spring. Time to start over again.
From the garage to the basement to the garden to the windows, all kinds of things need to be cleaned, renewed and refreshed.
So how about doing your portfolio while you’re at it?
One group of Canadian experts we consult regularly says this is just the time to do it.
Not just because it’s spring, but because the stock market offers a very revealing picture right now.
In the wake of the long stock market rally, it is getting easier to tell the contenders from the pretenders, say the independent researchers who publish KeyStone’s Small Cap Stock Report.
Look at each stock in your portfolio. “Ask yourself one simple question: is the fundamental reason I bought this stock still in place?”
These analysts come up with some portfolio-cleaning answers to that question. They are taking profits on four successful small cap stocks and anticipating a bright future for another one.
Turnaround baked in
The first quarter of 2010 ended with the markets up about 3.5 per cent for the year to date. Not bad, considering the sell-off in January.
But does this mean stocks are still a good bargain or not? To figure this out, this advisory goes to New York’s S&P 500 Index.
Trailing earnings are at about 25 times earnings per share (EPS). Historically, coming out of a recession into a recovery or expansion, they are 15-16 times EPS. “So historically, the market looks overvalued.”
Looking ahead, price/earnings (P/E) ratios are shrinking as corporate earnings recover. That’s encouraging, but the advisory is cautious. “The numbers are coming off depressed levels when much of the world thought we were heading towards financial Armageddon.”
In short, those attractive year-over-year figures may be a bit misleading. “In many cases, given the solid rally, much of the turnaround is already baked into the markets, broadly speaking.”
Rewarded or punished
For each investor, the crux of the matter is this. Which companies have goosed their earnings mainly by cutting costs, and which have done it the old-fashioned way, with real production?
As the advisory puts it: “Companies that produce solid top and bottom line growth, not just cost cutting measures, are being rewarded. Those that do the opposite will be punished.”
When you examine your portfolio, you are looking to see whether a stock will be rewarded for real growth. “If so, then continue to hold it,” says the advisory, “or buy even more, depending of course, on the valuation.” If not, it may be time to sell, although you may wish to keep half of your position if there is still hope of real growth in the future.
You may also have stocks that have grown so vigorously in share price and valuation that you may consider it “prudent to take profits.” This is what these researchers have done with four stocks.
A spectacular run
The four stocks in question are established favourites of this advisory. None of these small caps pays a dividend, by the way.
Asia Bio-Chem Group (TSX/V-ABC), maker of cornstarch (a staple in China) and owner of a new state-of-the-art plant in Daqing, has had quarter after quarter of solid results. The share price, less than 60 cents in August, has risen as high as $1.70 and now stands at $1.30.
Bridgewater Systems Corporation (TSX-BWC) makes the software that controls subscriber access to both mobile and fixed networks — letting people log on to their cellphones, for instance. It has had a strong climb in the past year, from below $4.00 to $11.60. It’s now at $9.97.
Sino-Forest Corp. (TSX-TRE) owns and manages vast forest plantations in China. It is in much better shape than many of Canada’s beleaguered forestry firms. A year ago it was less than $10. A month ago, it reached $21.70. It now trades at $19.67.
China Agritech Inc. (NASDQ-CAGC), a Chinese fertilizer maker, and the only one of the four to trade in New York, has had a spectacular run. $2.20 last April, it rose to $30.75 last month. It is now back to $18.95.
All of these small cap stocks have rewarded investors. All remain solid companies with good future growth prospects. But over the past several months, the advisory has been telling its readers to sell half or even all of its positions in these stocks at opportune times.
They have not abandoned the stocks. Bridgewater is listed as a hold in the latest issue of the advisory. The other three stocks are holds for now, but they remain long-term buys.
Formula for success
With the stocks they buy right now, says this advisory, “we are not necessarily buying the stock for what it will do next month or even the next three or six for that matter. We are positioning ourselves in profitable, growing companies for where they will be in a year or beyond.”
So it is with Zungui Haixi Corp. (TSX-ZUN), a firm that makes athletic footwear, casual leather footwear, apparel and accessories in the People’s Republic of China (you’ll notice that these researchers have studied China very closely).
This stock has all the things investors should be looking for, in this advisory’s opinion. It has posted solid earnings per share over the past year and with the stock around $3.00 — $3.05 today — its trailing P/E ratio is a very promising 7.5. EPS growth is projected to be 25 per cent over the next three to five years and the company has plenty of cash and no debt.
“There is no guarantee that management will deliver on the growth targets, and the strong Canadian dollar does impact currency translation in the near term, but the formula for success is in place.” It’s a Focus Buy.
Your formula for success as an individual investor is simple, the advisory suggests. If a stock is truly poised for further growth, cultivate it. If it’s gone about as far as it can go, weed it out.
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